In our previous article, we have discussed how to calculate dividend per share and the difference between DPS & EPS. In this article, we will be discussing how to calculate dividend payout ratio and what DPR tells you.
A company either pays a portion of its net profit as dividend to its shareholders in proportion to the number of shares held and retains a balance amount to reinvest in core business or retain the whole amount of net profit by not paying dividend.
The ratio of earnings paid out to shareholders as a dividend relative to the net profit of the company is calculated as dividend payout ratio or DPR. In other words, it’s a percentage of earnings paid to shareholders as a dividend, therefore it’s also referred to as the payout ratio.
Formula to calculate Dividend Payout Ratio or DPR
DPR is calculated by dividing declared dividends paid during a year by net earnings for the same year.
It’s reciprocal of retention ratio, which measures the percentage of profit a company retains for reinvestment to generate future growth. You can also calculate it by dividing dividend per share (DPS) by the earnings per share (EPS).
Dividend Payout Ratio or DPR = Dividends paid / Net Income
OR
1 – Retention ratio
Retention ratio = DPS / EPS
DPS can be calculated by dividing the sum of dividend for the whole year and the outstanding shares of the year. For Example, suppose a company has paid 10,000 rupees as dividend for the whole year and it has 5,000 outstanding shares. In this case, dividend per share or DPS is calculated as 2 rupees (10,000 / 5,000).
Earning per share or EPS can be calculated by dividing net earnings for equity shareholders by shares outstanding i.e. net earnings / outstanding shares. For example, suppose a company has 50,000 rupees as net profit for a year with shares outstanding of 25,000. The EPS for the company is 2 (50,000/25,000).
What Dividend Payout Ratio provides you
Dividend Payout Ratio or DPR will let you know how much profit a company is returning or giving back to shareholders, versus how much profit has been kept for expansion, for repayment of debt and as a cash reserve.
If a company has zero payout ratio then you can conclude, it has not paid dividend and retained 100% of net profit.
A high Payout Ratio means the company is reinvesting less amount of profit for future growth which will result in less capital gain in future periods. Similarly, low DPR means, company is planning to reinvest a higher amount of profit for future growth.
For example, let’s assume that a company has distributed Rs. 1 per share as dividend and its earnings per share is Rs 10. In this case, the company’s DPR is 1/10 = 10%. This means, company has retained 90% (100%-10%) of the profit for the future and 10% paid to shareholders by way of dividend. In this case, the dividend payout ratio or DPR is 10% and retention ratio is 90%.
If you are an income-oriented investor and do not prefer capital growth, dividend payout ratio should be a closely-watched financial measure. An investor seeking capital growth may prefer companies with low payout ratios.
As a part of dividend investing strategy, some investors prefer to consider dividend Payout Ratio to know whether to invest in a company that pays out high dividends versus a profitable company that has high growth potentials with less payout.
You can get details of total dividends paid, EPS and company’s net income from the reported financial statements.
Apart from the dividend payout ratio, you should also consider the following to assess whether a stock is fundamentally sound for your long-term investment.
- What is the company’s level of maturity? If it’s a new company, then it might not pay you a dividend as they prefer to invest all of their earnings for expansion or to develop new products. In that case, the company might give you good capital appreciation instead of dividend.
- Company’s dividend sustainability and its long term trends in the dividend payout ratio.
- Comparison of DPR within a given industry.
- What is the company’s dividend yield, which means how much a company has paid out in dividends per share over a year as a percentage to the amount invested per share. The yield is calculated by dividing annual dividend per share by current market price per share.
- What is the company’s intrinsic value per share?
- Is the company financially strong enough to invest?
- What fundamental analysis of a stock tells you for investment?
